The Lock-in Effect of California's Proposition 13

"The effect of Proposition 13 on mobility varies widely depending on the size of the subsidy, with the largest effects occurring in coastal California cities where the increase in property values has been greatest."

Proposition 13, adopted by California voters in 1978, mandates a property tax rate of one percent, requires that properties be assessed at market value at the time of sale, and allows assessments to rise by no more than 2 percent per year until the next sale. This means that as long as property values increase by more than 2 percent per year, homeowners gain from remaining in the same house because their taxes are lower than they would be on a different house of the same value. Proposition 13 thus gives rise to a lock-in effect for owner-occupiers that strengthens over time. It also affects the rental market, both directly because it applies to landlords and indirectly because it reduces the turnover of owner-occupied homes.

As a result of Proposition 13, there are obvious distortions in the real estate marketplace. For example, in 2003 financier Warren Buffett announced that he pays property taxes of $14,410, or 2.9 percent, on his $500,000 home in Omaha, Nebraska, but pays only $2,264, or 0.056 percent, on his $4 million home in California. Although Buffet is known as an astute investor, the low property taxes on his California home are not attributable to his investment prowess, but rather to Proposition 13.

In 1992, the U.S. Supreme Court upheld Proposition 13, in part on the grounds that it furthered the policy goals of increasing "...local neighborhood preservation, continuity, and stability." In Property Tax Limitations and Mobility: The Lock-in Effect of California's Proposition 13 (NBER Working Paper No. 11108), authors Nada Wasi and Michelle J. White examine how Proposition 13 has affected the average tenure of owners and renters in California versus other states. They find that Proposition 13 definitely furthered continuity and stability, because it caused a substantial increase in the average tenure of California households relative to that of households in other states. From 1970 to 2000, the average tenure of California homeowners and renters increased by 1.04 and .79 years relative to that of homeowners and renters in the control states. These figures represent increases in average tenure of 10 percent and 19 percent, respectively.

The large effect of Proposition 13 on renters' tenure is particularly striking and suggests that longer tenure by owner-occupiers forces younger households to delay their transition from renting to owning. The authors also find that African-American households responded more strongly to Proposition 13 than white households and out-of-state migrant households responded more strongly than native-born households. From 1970 to 1990, the tenure length of African-American homeowners and renters increased by 1.3 years and 1.8 years, respectively, relative to that of white homeowners and renters. From 1970 to 2000, the tenure length of migrant homeowners and renters increased by 1.5 years and .6 years, respectively, relative to that of native-born homeowners and renters.

The effect of Proposition 13 on mobility varies widely depending on the size of the subsidy, with the largest effects occurring in coastal California cities where the increase in property values has been greatest. From 1970 to 2000, average tenure length increased by less than one year in inland California cities, but by more than two years in the Los Angeles area and by three years in the Bay area. As the authors suggest, whether the Proposition 13- induced increases in continuity and stability have been worth the cost in lost tax revenue and the resulting redistribution from inland to coastal California communities remain subjects for further research

-- Les Picker

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